5/14/2001 @ 12:00AM

Cisco kidding?

Fans hope that $3.5 billion in writedowns can set up a return to greatness for the company that powers the internet. But with an ailing stock and an unraveling strategy, the real trouble may lie ahead.

No wonder Cisco Systems thought that it could do no wrong. In 16 years of selling millions of network routers to businesses and buying dozens of other companies, it was a paragon of high-tech growth. It took a decade to hit $1 billion in sales in 1994, then quadrupled to $4 billion in two yearsand quadrupled yet again in fewer than four years. Even with its stock off 80% in a year, $10,000 invested when it went public in 1990 is still worth $2.4 million.

It’s hard to blame John Chambers, Cisco’s CEO, for a little swagger even as he swallows a $1 billion restructuring charge, writes off $2.5 billion in inventory and axes 8,500 jobs (17% of the payroll). He sounds strangely unhumbledor eerily in denialas he compares Cisco’s woes to the rare disaster of a once-in-a-century flood.

He vows that Cisco can return to the torrid growth that is its birthright. Much of Wall Street is quick to forgive, yawning at the big writeoffs. In the days after Cisco posted the $2.5 billion inventory charge, its stock held its own. Among people with short memories, hopes are high for a fast rebound.

But Cisco may be kidding itself. Rather than an aberration, this stumble could be endemic. The two big engines of Cisco’s future growthacquisitions made with fearless alacrity and a foray into fiber optics to expand from corporate networks into the far bigger market for supplying telecom carriershave stalled. Since 1993 Cisco has spent $34 billion to buy 71 companies, including $10.3 billion in two years to buy optical upstarts. Now Cisco is pulling back.

In today’s bipolar market it is hard to buy anything, says Michelangelo Volpi, Cisco’s chief dealmaker. “The valuation of everything changes so quickly, I don’t know if I’m paying too much or too little.” Before buying again, “we have to understand what things cost.”

Yet in 1999 Volpi had no problem shelling out $6.9 billion in stock to buy Cerent, an optics shop with just $10 million in sales.Aimed at the telcos, it was the first big piece of a three-part optical package: Cerent’s gear for routing bits within a metropolitan area; high-speed optics to handle traffic at a network’s center; and long-haul laser gear to zap data between the two. Cisco added Monterey Networks for $500 million in stock to get the second piece of its “end-to-end” optical portfolio. For the third long-haul transport Cisco paid $2.15 billion in stockabout ten times salesto buy Pirelli Optical Systems.

Only the Cerent deal still looks good. Cisco has built the metro part to about $1 billion in sales. That hundredfold growth compared with what Cerent was doing, however, seems unlikely to continue. The telcos racing to ring U.S. cities in fiber are drowning in debt. A long-awaited upgrade to Cerent gear could help, and Volpi says the upgrade is “ready”but when pressed he admits it remains in “the late stages” of testing.

Cisco scrapped the Monterey part of its strategy last month, in essence walking away from a $500 million investment. It had bought Monterey before the latter’s core product was finished, and in 20 months Cisco couldn’t get past field trials.

Nor does the Pirelli deal look especially promising. Cisco won’t say how much long-haul gear it has sold since buying the Italian company late in 1999, but outsiders are dubious. “We never understood why they bought Pirelli. It was never on our short list of suppliers,” says one big Cisco customer.

Volpi admits that after two years of pursuing an “end-to-end” strategy, its “initial focus” is only on the first end served by Cerent. That’s hard to glean from Cisco’s press releases.

Cisco needs to gain in telecom to keep growing. Its 80% share of its core marketrouters sold to businessesleaves little room for expansion, especially as companies slow their tech spending. But in telecom, big players worry about relying on Cisco when it sells only metro gear. “The vendor has to give us the capability for end-to-end,” says Hossein Eslambolchi, who runs AT&T’s network. “Giving us the individual elements isn’t enough.”

Out of necessity, Cisco is now seeking to grow elsewherein wireless, storage and voice calls over the internet. Underlying it all is Cisco’s certainty in the spread of the net, whose data traffic still doubles every month. But with prices uncertain, telecom clients reeling and upstarts like Juniper Networks gaining, Cisco’s old certainties seem as out of place as its propensity for swagger.